The Indian Real Estate Bubble — circa 2008
There was a post on IEB in December 2006, on whether there was a bubble in Indian real estate (Link), courtesy IEB reader Annamalai Veerapan.
16 months later, Annamalai is back with a follow up post on the real estate bubble. It is reproduced below in full –
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Who owns real estate loans in India?
I’ve been waiting for some official confirmation of the bursting of the real estate bubble in India. Although bursting of the bubble (or even the existence of it) is still just hearsay, it is widely accepted that Indian real estate market is stuttering (to put it the best way I can). This article in the New York Times puts the depreciation in New Delhi and surrounding areas at 20%. I thought this is a good time to do a followup on my first post on Indian real estate.
In the midst of the bursting housing bubble in US, UK, Spain, Ireland ..etc., sub-prime has become a common word (it also was nominated as the word of the year). There are several articles, blog entries and web sites detailing the life cycle of a mortgage loan in these countries, especially in the US, talking about how these loans are converted to Mortgage Backed Securities (MBS) and packaged as Credit Default Obligations (CDO) and sold to hedge funds, central banks, private investors and investment banks. Although it is not exactly known who owns how much of the toxic mortgage loans, at least we know what happens to these loans in a general sense. This is very important in the current scenario for any kind of safe investment in the stock market or even to have a decent understanding of the current complex derivative based economic environment.
I’ve been trying to find out what happens to a mortgage loan made in India. Does the bank own it? Or do they sell it as MBS? If they sell it as MBS who buys it? What are the risks for ICICI, HSBC and the other large mortgage lenders in India, if there is a 20% to 50% crash in real estate prices in India? Does India also have a fractional reserve banking system? With the foreclosure process in India not that well defined who will end up holding the bag?
All these questions arise if we assume a deflating housing bubble. I know many readers still feel that there is no housing bubble in India. Let us keep that aside for the time being and let us assume hypothetically that there is a bubble in India and it will deflate 20-50% and and try to answer the following
- What does ICICI/HSBC do with a mortgage loan they issued?
- Are there any organizations equivalent to Countrywide/ New Century whose main role is issuing mortgage loans?
- Are mortgage loans in India securitized and sold?
- If yes, to the above question, who are the buyers of these securities?
- What is the foreclosure process in India? How simple and efficient is it?
- What happens when someone defaults on a home loan in India?
I’ve done some (re)search and I will sum it up in the next email/ post.
“What happens when someone defaults on a home loan in India?”
Well, I assume Indian banks are banks like everywhere else (except N. Korea, LOL) and work the same way. For starters, the Indian real estate market IS a bubble and if I were a bank I would be salivating. If a borrower can not service his mortgage anymore the loan is revoked and his house will be taken over by the bank. If he has paid up for, say, 2 years already that money is gone and so is his house. Excellent business for banks.
As for securitizing home loans in all the various ways, first I don’t think the expertise is there in India and most importantly I doubt there would be a market to sell into.
Comment by Hans — April 18, 2008 @ 8:03 pm
Hans, may be you want to check this
http://economictimes.indiatimes.com/News/News_By_Industry/Banking_Finance_/Banking/ICICI_announces_Indias_largest_securitisation_programme/rssarticleshow/2879574.cms
Not sure if the issue was a success.Ofcourse this is still a far cry from the alphabet soup that US banks have managed to create.
To the IEB readers: Shouldn’t RBI be credited for jumping in 2006 and curtailing the off balance sheet financing by banks? On hind sight it seems to have been a very good move
Comment by barbadkatte — April 18, 2008 @ 10:56 pm
even if there is a bubble in indian real estate, banks might not do bad…the simple reason being a bank in India pays only 90-95% of the declared value of the apartment, but the actual value at which its being traded may be 1.5 (or more) times that. So the borrower has much more equity and hence less prone to default…hence good for the bank.
Comment by swap — April 19, 2008 @ 3:11 am
Hans,
That’s good business if property values are not crashing. If property values crash by 30% or more per annum ,they make huge loss. Give u an example. In 1998 our neighbour’s home was valued at 30 lakhs. In 1999 it was valued at 17 lakhs. That’s a depreciation of over 40%. That can be loss making even if the loan was paid for 2 years
Comment by satish — April 19, 2008 @ 4:51 am
Note as swap mentioned,
All the realestate boom you see is not “official”. Because in India anywhere the land rates are “fixed” by the govt.
Regular banks provide money only for this official value, sometimes may go up to even 100% but the market value even in the most depressed time will be minimum 1.5-2(usually 5-10) times that value.
Would you believe that official rent of my house would be somewhere around 400 but market rate is 6000?
Comment by Ravi — April 19, 2008 @ 12:03 pm
Let’s analyze the sector and company data:
Background:
first of all, indian mortgage market is a tiny fraction of US-counter part. Our total loan-advances (all loans..not just mortgage) is around <$0.5 triilion is 2.3% of US Advances.
That kind of massive asset-requirements drove the US banking system to securitization in mid 90’s where these recievables were being bundled up and offered as bonds to investors, with initial sole purpose of freeing up capital to do more business . The problem lies with investors who seem to have miscalculated the risk being taken for these returns. Good amount of CMBS (commercial mortgage) is still being floated into market in this quarter also, with relatively no issues as it’s usvally taken by hedge-funds with good risk-modeling in
terms of pre-payment namely extraction and contraction risks.
When overseas investors and banks got into this market as buyers , ignorant of underlying risks and attracted by higher yields..things got over-heated. 1yr back, my blog had an article on this at http://policycritique.wordpress.com/2007/08/10/credit-squeeze-from-all-corners-blame-whom/
Let’s take ICICI (10% share in total loan advances in india) as our candidate for analysis.
(Sources: 178 page Annual report of ICICI for yr2007 is the sole source that’s been analyzed to provide any summary info below for that bank)
How do we issue/support loans:
Unlike western counterparts, our banks mostly fund thier lending with thier deposits and little bit of borrowing. ICICI’s $50 billion loan advances (real estate loans constitute $20 billion) and $20 billion is mostly funded by a) $56 billion deposits and b) $12 billion borrowing.
CDO market is relatively new even in US (last 2-3 yrs). But, MBS is being used for a long time to securitize mortgage receivables. Securitization is a sophisticated model driven process of building multi-tranche bonds upon the underlying passthrough securities with built-in derivatives to account for any internal credit enhancements of these offerings to get good rating from SP and moodys and these tranches offer different risk-return profiles that suit investors with different floating-rate obligations across various time-horizons.
In india, It was being slowly mainstreamed by these private banks (ICICI, HDFC) trying to grow faster by originating these loans and trying to offload them to release the capital for further lending.
Securitization:
Again, ICICI securitized around 1.5 mil loans worth $2.8 billion. It had an obligation in terms of guarantees for around $400 million of that, which explains the relative low-offtake of these with the buyers and lack of depth in our financial mkts to support this ecosystem. But, again it’s a good start.
Offloading NPA/ foreclosures:
Over the last 3-4 yrs, a new recovery/liquidation process with in indian system is to sell these distressed loans to a third party aggregator. One of them named ARIC, bought around $300 million distressed receivables from banks.
Comment by Siva Moturi — April 19, 2008 @ 2:29 pm
I would like to mention that CDOs, as mentioned in the article are actually Collateralized Debt Obligations. These represent a pooled set of mortgage backed securities, sold by mortgage lenders into the market. They can include a mixture of sub-prime, prime and Alt-A mortgages. Credit Default Swaps are a form of financial instrument primarily used as a hedge in the corporate bond market, and their lender financial institutions.
Comment by Observer — April 19, 2008 @ 5:43 pm
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Annamalai Veerapan, Siva Moturi and others, keep this one going fellas. I’ve been waiting to see how this whole thing works out. Great reading now that the sub prime mess has brought this issue to the forefront.
Annamalai Veerapan’s post material has been well discussed among my real estate friends who calmly assert that rent is not the only factor to be looked at. In other words land appreciation is more important. Of course that gets shot when prices start to crash as has been discussed already.
So another question: What scenario do we see where prices are to crash? So far since the 90s prices have only stagnated but have never dropped in prime metros. From my observations, land prices in prime locations are only going to go up for several years to come as more and more demand is created.
Comment by Nikhil Nayak — April 26, 2008 @ 10:39 am
Siva thanks for the informative post on ICICI with respect to mortgage loans.
Nikhil, I’m in the ultra bearish camp with regards to Indian real estate. I expect 50-60% price declines in the next 3-5 years.
Its not correct to say that prices have never gone down since 90’s. In the mid 90’s prices went down in all metros in India. Robert Shiller’s book “Irrational Exuberance” (second edition) has documented that in and around Delhi the prices went down about 20% during the mid 90’s. In Coimbatore I have seen prices going down from 1.2 lakhs to 85K per cent of land near my home. I have a first hand anecdotal evidence from my friend of a price drop of 30-40% in Pune. I think the reason not many noticed it, was that there was no mass speculation. But recently speculation in real estate has been en-masse and has been in a scale never seen before.
Now I’m trying to traverse the what would and what if scenarios after a real estate collapses in India.
I’m trying to blog on ‘Indian Real Estate’ at http://surreal-state.blogspot.com/. Planning to be more active in the future….
Whatever it is, we are living in very interesting times.
Comment by Annamalai Veerappan — April 26, 2008 @ 5:33 pm
AIG has just got an approval from RBI to start a business where they will be taking over some of the risks of the bank’s home loans onto it books. I don’t really know the details of this process, but apparantly this is a big business worldwide
Comment by Victor — April 28, 2008 @ 10:09 am
Annamalai Veerapan, I am not too sure about your predictions just based on what we are seeing in terms of investment headed this way. While its true that the IT parks etc are going to see price pressure there’s a whole new wave of demand coming on with manufacturing and infrastructure investments.
While Coimbatore may have seen fluctuation earlier word is out and you can be sure that prices are going up there very soon. Another place is Kakinada where an estimated 50,000 crore (approx $11 billion) is going to be invested by Reliance, ONGC and others. I would be shocked to see prices drop at all in major cities for quality constructions in major metros.
If prices drop its going to be in the outskirts where speculative buying and selling is going on right now.
Comment by Nikhil Nayak — April 29, 2008 @ 10:53 pm
I agree with this
Comment by Sneha — May 1, 2008 @ 11:20 am
Well one of our professor has a theory that due to black money and stamp duty all house transactions in India are70% black and 30% white on average. It is only white portion on which banks give loan. So incentive to default is less in India as compared to USA as a person’s house real worth is much more than than the loan he or she has taken.
I don’t have any data to support this but would like to know view of people who are researching on this topic
Comment by anshul — May 8, 2008 @ 1:41 pm
Ohh!! You cannot imagine the happiness I get when I still see the advertisements of projects I used to visit some 6-7 months back..
These builders have tortured common people like me for very long.. and now I can see that they are desparate to sell off the vacant flats..
Me and my friends still enquire to many builders on a regular basis and its a common knowledge that no-one is willing to buy a pigeon hole which will leak in rainy season and which is 20 kms from heart of the city..
I always wondered , how these builders could shamelessly ask for 35-40 lakhs for flats which looked like chawls and not even worth 10 lakhs..
well , its pay back time..
3 weeks back , PBAP increased rates in Pune by 5- - 400 rs PSF..
Thatwas the last attempt to tell the world that Pune property is still rising..
What a fiasco..
Some people might have been lured to buy flats , because of this new rate increase..
PEOPLE , dont fall trap to this new game from builders lobby.. there is no hurry to buy flats which are being sold at twice their actual price..
The current market sentiment has confirmed that a correction was long due in real estate as well as stock.
I know for sure that real estate is 20-30 % low in Delhi and bangalore.
I am waiting for a correction in Pune real estate for last 1 year.. ( 2BHK in Wakad at 40 lakhs , 2 BHK in Kharadi at 38 Lakhs.. are you kidding me ?? what do these builders think .. if this is california outskirts ?? )
I also got confirmed news , that in a recent meeting of PBAP , they decided to boycott any builder who reduces rates..
but then , well there was Mont Vert who does not belong to that league.. after reducing the rates for their upcoming projects last week end, Mont Vert has started the downfall of these greedy builders at last..
this could well be the start of the buyers market.. and I think the downfall in real estates will happen over next 1 year..
But then , my question is “How do you know when is the right time to buy? ”
Do I wait another few months?
I know for sure that second hand flats in good areas are being sold at a bargain..
So what should be the best time for all of us to book a good flat in coming months / years :-)
Comment by Bubble will burst — May 9, 2008 @ 3:50 pm
Ha! The Pune real estate story is a real fantastic story, driven by speculators, “feel rich” IT folks in Hinjewadi and similar guys. No local job in Pune for the average Engineer/CA/Doctor (non-IT) can pay enough to cough up 50-60 lakhs for a flat which till recently could cost not more than 10 lakhs max. With zero amenities to speak of, no high local income (as compared to say Mumbai- on an average all salaries in Pune may be 30-40% lesser than in Mumbai) it is wonder that the boom is still lasting. It has always been an enigma to me as to the identity of the ultimate buyers of these flats. Or is it circular trading ? ( A sells to B at 20% margin, B sells to C at further 20% margin and then it goes back to A who again sells to B,etc. As long as the trades happen and cash flows back and forth everybody thinks they are making a lot of money)
One hypothesis that I have is that these flats are mostly bought by senior citizens whose sons/daughters are in US in IT job, who send them loads of dough-not knowing what to do with, say 20-30 lakhs at a time- the old geezers straighaway plonk it into a flat and forget about it. After all, house prices never come down? Right?
Comment by Cool Head — May 10, 2008 @ 8:59 pm
Look at this comparison of rent vs buy option in Bangalore. It indicates a big price correction soon
http://bangalore.craigslist.co.in/rfs/674729675.html
Comment by Shyam — May 10, 2008 @ 10:07 pm
Well, Shyam, this is not a new phenomenon. Even in Mumbai, Pune the rental yields on residential property have always been low (not as low as in Bangalore but in the range of 5% or so).
This is similar to the Indian mentality in buying shares in companies. Nobody buys it for dividends but only for the capital appreciation.
Comment by Cool Head — May 11, 2008 @ 7:24 pm
well i have been hearing about bursting of bubble for last one year but nothing hs actually happened and price of my rented flat (in delhi) has only gone up. but there seems to be so few transactions it is difficult to say that prices are down? what seems to have happened is that nobody is selling and buyers are waiting for correction.
meanwhile retals have gone up very fast and there is very limited supply? we can say that buuble is burst only when people start selling at lower prices
As for problem that mortgage lender might have in case of crash - worries expressed here are meaningless indian mortgage market can not be compared to US market here home equity is very high as stated price of purchase is rarely more than half of actual price so even with sharp crash there will be very few foreclosures
Comment by indrajeet — May 12, 2008 @ 2:14 pm
This is in response to the post about 90s stagnating real estate prices. Since inflation in India mostly hovered in the 8 to 15% region during much of the early 90s, this would mean real estate prices adjusted for inflation (real) actually dropped.
This is what might happen in the present, with nominal prices stuck at the same level for a couple of years and inflation running at 6 to 10%.
Comment by Rohan — May 15, 2008 @ 1:56 am